On Sunday, Robert Knakal (of Massey Knakal Realty Services ) posted this article to his blog:
Do Politicians Understand the Banking Industry?
Last week, the president announced a new "Financial Crisis Responsibility Fee" (they didn't dare call it a tax!) to be paid by the largest banks in order to recover expected losses from the Troubled Asset Relief Program. Welcome to yet another chapter in the year-long crusade by legislators to revive private sector business by vilifying, assailing and soaking it.
The banking industry is a critical element of our commercial real estate market and we have been negatively affected by the disappearance of many of the large commercial and money center banks from our lending market for nearly two years now. For this reason we must look carefully at how Washington deals with these companies.
The president is asking for large banks, thrifts and insurance companies, those with assets in excess of $50 billion, to foot the bill for all TARP losses. This would be done through the implementation of a 15 basis point tax on the liabilities of the banks, less Tier 1 capital, or high quality capital such as common stock, disclosed and retained earnings and capital which carries FDIC guarantees. It is expected that about $100 billion will be raised over 10 years from the new tax.
This proposed tax will surely pass in the House. Whether it passes in the Senate, or is even constitutional, is another story.
One of the problems with this tax is that it does not take into consideration that banks were not the only recipients of TARP money. The auto industry, Fannie Mae and Freddie Mac (and a program to help homeowners avert foreclosure), and AIG also received funds from TARP. In fact, most of the banks have repaid their TARP money, including almost $20 billion in interest, and most of the losses are expected from the auto industry and AIG.
Some of the banks reluctantly took this money in the first place. Had they known, at the time, that their compensation would retroactively be scrutinized and capped and that their obligations would amount to joint and several liability, I doubt they would have signed up if they did not absolutely have to.
There are a couple of aspects of the TARP that we must consider. First, the capital doled out was in the form of "investments", not corporate welfare or entitlement payments which the taxpayer never intended to get back. As it has turned out, some of these investments were sound, and some not so much.
Why should those in whom sound investments were made be forced to pay for those that the government was ill-advised to invest in?
Second, taxpayers were acting in their own interests in bailing out the system. They weren't doing anybody a favor. Money wasn't "spent" to bailout the banks. Taxpayers merely traded one claim for another, trading dollars for claims on real assets such as housing, commercial property, industrial equipment and corporate equity. The value of these assets had been depressed further than economics would dictate out of the fear that the taxpayer wouldn't intervene. Taxpayers acquired these assets on a bet that asset value would increase simply based upon their intervention. In most cases they were correct.
In fact, the Fed now has a balance sheet about the size of Citigroup's and, last week, reported gigantic profits of $52 billion for 2009. This is only slightly less than Wall Street reported as a whole. This throws interesting light on the president's comments that the new tax must be imposed to "recoup" bailout costs.
But why single out the banks, which are showing the Treasury a handsome profit on its TARP investments? Are politicians now the judge and jury when it comes to attributing liability for the financial crisis? How many times have you heard officials say, "Wall Street caused this mess?"
It is dangerous for the U.S. to have politicians determine culpability and then use tax policy to penalize those who they indict without even going through a formal process.
There are many industries which had a hand in the crisis. It would be easy to point to the policies of many administrations which sought to increase the homeownership rate in the U.S. This exerted pressure on the GSEs to relax requirements which inflated housing bubbles (Many believe this was the underpinning of most of the crisis. Most of the CDOs and derivatives which became toxic were based upon housing policies). In the early 2000's, there were concerns that Fannie and Freddie were spiraling out of control. Barney Frank was outspoken about how they should be left to do what they were doing. How would Mr. Frank feel if the next administration raised his personal tax rate to 75% due to his contribution to the crisis?
Last week and again this week, we will hear about strong earnings from Wall Street firms and the customarily large bonuses which move in tandem with these earnings. These have caused resentment from Washington, which can't connect the dots to see that the elimination of two giant competitors (Lehman and Bear) and, more importantly, their highly accommodative monetary policy is the main reason for the earnings. And yes, it is the administration's monetary policy, not the Fed's. Presumably, the White House approves of the Fed's monetary stance or they would not have proposed Chairman Bernanke for another term.
This tax is all about politics, not about TARP repayment. Why are the automakers exempt? Why not consider a tax on General Motors, Chrysler and their unions? The automakers were the worst "investment" the government made and will likely be the largest source of TARP's projected $68 billion in losses. These losses will stem from the political decision to restructure rather than liquidate GM and Chrysler which filed for bankruptcy protection last year.
The largest beneficiary of the car companies' bailout was arguably the United Auto Workers Union which emerged with a far better deal than did bondholders and other senior secured creditors. The losses on TARP investments are compounded by the unaltered pension plans for union members. In a typical bankruptcy, a 10-year, $40 billion pension obligation would be reduced to about $10 billion or eliminated altogether. Add $30 to $40 billion to the taxpayer's tab for this benefit and you really have to question the advisability of saving these companies, particularly when looking at their financial forecasts moving forward. They did, however, support the president in his election run, so there you have it. Throw in a juicy exemption from the additional taxing of their "Cadillac" healthcare plans for good measure!
So the administration goes after the banks because it is politically favorable. Do they really think this tactic will work economically? What is likely to happen if this tax is passed by Congress?:
1) It will exert even more disincentive for banks to lend. They will have less capital available to lend and the loans they do make would be subject to this tax. This flies completely in the face of the administration calling for banks to lend more to businesses. It would also be a setback for our real estate capital markets.
2) It would create a disincentive for banks to merge for fear of going over the proposed or amended asset threshold. Mergers are effective strategies, particularly in difficult times. This would also reduce the number of bidders the FDIC would see at their sales of banks they take over.
3) It could threaten U.S. bank's ability to compete with overseas rivals which are not subject to the tax.
4) Some of the banks may try to avoid part of any tax by selling more brokered deposits in the wholesale market. If that happens, traditional commercial banks and the FDIC will not be pleased.
5) It is likely that the new tax would simply be passed along to consumers in the form of higher ATM fees or the like.
Jumping on the "Banker bonuses are too high" and "Make the big bankers pay" bandwagon is simply an attempt to gain political favor. The president suffers from the worst approval ratings and highest disapproval ratings a U.S. president has seen after 1 year going back to Jimmy Carter.
What Mr. Obama and others apparently fail to understand is that banks' own shareholders benefit from these huge performance bonuses. The bonuses are typically tied to those who make large profits for their employers. Burst of outrage from politicians or even grilling bank CEOs in front of a congressional hearing will do little to impact this system. Bonuses may consist of more stock than cash today but the amounts are still high. The public has been giving the banks credible and convincing votes of confidence all year by bidding up the value of their shares. It cannot seriously be argued that investors are ignorant of bonus arrangements.
If Congress really wants to change the behavior of banks, they must convey that no bank is too-big-to-fail. This implicit guarantee keeps risk taking high and will cause a focus on the short-term as opposed to the long-term. The $50 billion litmus test is not the right answer either. CIT, an entity with over $50 billion in assets, just went through bankruptcy and, by any objective reckoning, there were no systemic consequences. The new $50 billion tax level has lowered the bar and increased the scope of future bailouts by drawing a wider circle around firms that can gamble with implicit federal backing. Do politicians really think about the ramifications of their positions before they publically announce their ideas?
Coming up with a plan that allows failure is, no doubt, hard work. Perhaps reintroducing Glass Steagall or a similar platform which separates traditional banking from hedge-fund trading. Perhaps the answer is what a bipartisan Senate effort is considering; the creation of a special bankruptcy court to decide whether an institution should go through bankruptcy or be subjected to an FDIC resolution process.
Another idea to reduce the moral hazard of too-big-to-fail would be to restore long-ago limits on leverage. For instance, eliminate the corporate income tax for financial companies and replace it with a tax on assets that rises with the bank's leverage ratio. There could be a tax-free zone at leverage levels below present regulatory standards. Margin requirement reforms could also be a component of this platform.
If a bank is truly too-big-to-fail, it should be dismantled into smaller pieces that the economy can digest. Simultaneously, the government should make it clear that it will allow these institutions to fail. This would do more to enhance the integrity of the risks that are taken, and the compensation that is given, much more than any punitive tax policy would.
Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York and has brokered the sale of over 1,050 properties in his career.